Dealpolitik: Sealy Deal Raises Trifecta of Delaware Law Issues

The circumstances surrounding Tempur-Pedic’s agreement to acquire Sealy for $2.20 per share raise a trio of corporate law issues awaiting clarification by the Delaware courts.

First, the deal is presented as all but a fait accompli from a corporate governance perspective. No shareholder vote is required since KKR and a few other shareholders had sufficient shares to approve the deal before it was announced Thursday. Second, the merger agreement provides for a limited opportunity for a competing bid. Finally, the deal comes amid a long-running battle with dissident shareholder H Partners, which has complained about dividends and fees KKR has been paid while those who invested in the initial public offering at $16 per share will realize an 86% loss at the deal price. (Some Sealy competitors failed in the financial crisis, but KKR in 2009 invested $90 million in Sealy.)

Each of these factors touches on unsettled areas of Delaware corporate law.

Bloomberg News

Avoiding a shareholder vote. In the ten-year-old, much maligned, Omnicare case, the Delaware Supreme Court ruled that a majority shareholder could not agree in advance to guarantee shareholder approval to a merger. Since that case, techniques have developed to get around the Supreme Court’s proscription. Tempur-Pedic and Sealy appeared to use such an approach by requiring and obtaining majority shareholder approval within 48 hours after the signing of the merger agreement. This technique has been explicitly approved by the lower court in Delaware.

However in both the leading cases giving such approval the board had undertaken at least a limited sales process to see if there were higher bidders. Published reports have indicated that before signing the Tempur-Pedic deal Sealy spoke to multiple potential buyers, both strategic and financial, though we won’t know precisely what process Sealy conducted until we see the background section of its information statement under SEC rules.

Opportunities for Competing Bids. There is continuing controversy in Delaware about the extent to which pre-signing shopping of a public company is required if at all, and the avoidance of a shareholder meeting could shine a spotlight on the issue in this deal. Under the Revlon decision in Delaware, the Sealy directors have a fiduciary duty to take all reasonable steps to obtain the highest possible price.

The merger agreement doesn’t contain a “go shop” that would allow Sealy to solicit a better deal after signing the merger agreement last Thursday. It does however, contain a 35 day period during which Sealy could accept a higher bid if it came in without being solicited, which is sometimes referred to as a “window shop.”

This period is much shorter than that in a typical public company deal. Delaware law would require the window shop period to be open at least until the shareholders approve the transaction, which for regulatory reasons, usually takes at least 60-90 days in normal public company deals. Here, since there is no shareholder meeting, the window shop could, as a mechancial matter, have been omitted entirely. However, whether the 35-day window shopping provision is sufficient to satisfy the directors’ fiduciary duties under the Revlon case will depend on whether the directors have taken all reasonable steps to maximize the price given all the facts of the situation.

Potential Conflicting Interests and the Entire Fairness Standard. Finally, the third area of uncertainty under Delaware law this deal touches upon is whether the interests of KKR, which controls 46% of the Sealy shares, conflict with those of other shareholders. If there were sufficient conflicts and Sealy were deemed to be controlled by KKR, the business judgment rule wouldn’t apply to the directors’ decision to approve the Tempur-Pedic merger agreement. Instead, for the deal to be upheld, it would need to meet a higher standards, namely that the directors would need to demonstrate that the transaction is entirely fair to the public shareholders of Sealy.

On the surface, it does not appear that KKR is receiving anything in the merger different than other shareholders. However, recently there has been significant commentary in Delaware as to whether a controlling shareholder’s desire for liquidity should be considered a conflicting interest. In the case of Sealy, KKR has been subjected to criticism by H Partners both for its management of Sealy and taking millions out of the company through dividends and fees over the course of KKR’s ownership.

Could KKR’s desire to end the controversy with H Partners by a sale and avoid further attacks create an interest causing the entire fairness standard to apply? It is not clear. The press release announcing the deal indicated that an independent committee of the board had been formed and retained its own lawyer and financial advisor.

There is a potential here for litigation on cutting edge Delaware law issues and that may be why the Sealy stock is trading almost exactly at the $2.20 deal price. However, most of this type of litigation settles for little or no additional purchase price and a bit of extra disclosure, and legal fees.

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